ECO45 - Midterm

According to the quantity theory of money and the Fisher equation, if the money growth increases by 3 percent and the real interest rate equals 2 percent, then the nominal interest rate will increase:

5 percent.

Consider the money demand function that takes the form M / P = kY, where M is the quantity of money, P is the price level, k is a constant, and Y is real output. If the money supply is growing at a 10 percent rate, real output is growing at a 3 percent rate, and k is constant, what is the average inflation rate in this economy?

7 percent

If the government raises taxes by $100 billion when the marginal propensity to consume is 0.6, what happens to each of the following variables?

Public saving will increase by $100 billion. Private saving will decrease by $40 billion. National saving will increase by $60 billion. Investment will increase by $60 billion.

According to the model developed in Chapter 3, when taxes are increased but government spending is unchanged, interest rates:

decrease

An increase in the supply of capital will:

decrease the real rental price of capital.

If the money supply is held constant, then an increase in the nominal interest rate will ______ the demand for money and ______ the price level.

decrease; increase

When a firm sells a product out of inventory, investment expenditures ______ and consumption expenditures ______.

decrease; increase

If inflation was 6 percent last year and a worker received a 4 percent nominal wage increase last year, then the worker's real wage:

decreased 2 percent.

A woman marries her butler. Before they were married, she paid him $60,000 per year. He continues to wait on her as before (but as a husband rather than as a wage earner). She earns $1,000,000 per year both before and after her marriage. The marriage:

decreases GDP by $60,000.

The investment function slopes ______ because there are ______ investment projects that are profitable as the interest rate decreases.

downward; more

In a fractional-reserve banking system, banks create money because:

each dollar of reserves generates many dollars of demand deposits.

The ex ante real interest rate is based on _____ inflation, while the ex post real interest rate is based on _____ inflation.

expected; actual

In the long run, the level of national income in an economy is determined by its:

factors of production and production function.

Suppose workers can move freely between being farmers or being barbers (i.e., no additional costs are required to switch between occupations). This implies that the nominal wages of

farmers and of barbers will be equal.

People use money as a store of value when they:

hold money to transfer purchasing power into the future.

The neoclassical theory of distribution explains the allocation of:

income among factors of production.

The demand for real money balances is generally assumed to:

increase as real income increases.

If the reserve-deposit ratio is less than one, and the monetary base increases by $1 million, then the money supply will:

increase by more than $1 million.

Suppose that a change in transaction technology reduces the amount of currency people want to hold relative to demand deposits. Complete the following statement. If the Fed does nothing, the money supply will tend to ______. However, the Fed can hold the money supply constant by ______ bonds in open-market operations.

increase; selling

Over the past century, the productivity of farmers (MPLf) has risen substantially due to technological progress. According to the neoclassical theory, farmers' real wage (Wf/Pf) should have

increased

Inflation ______ the variability of relative prices and ______ the efficiency of the allocation of resources.

increases; decreases

According to the model developed in Chapter 3, when government spending increases without a change in taxes:

investment decreases.

When bread is baked but put away for later sale, this is called:

investment in inventory.

The demand for loanable funds is equivalent to:

investment.

A small country might want to use the money of a large country rather than print its own money if the small country:

is likely to be unstable, whereas the large country is likely to be stable.

When a firm sells a product out of inventory, GDP:

is not changed

The classical dichotomy:

is said to hold when the values of real variables can be determined without any reference to nominal variables or the existence of money.

In the United States, the money supply is determined:

jointly by the Fed and by the behavior of individuals who hold money and of banks in which money is held.

When the demand for loanable funds exceeds the supply of loanable funds, households want to save ______ than firms want to invest, and the interest rate ______.

less; rises

According to the classical theory of money, reducing inflation will not make workers richer because firms will increase product prices ______ each year and give workers ______ raises.

less; smaller

Assume that an increase in consumer confidence raises consumers' expectations of future income and thus the amount they want to consume today for any given level of disposable income. This shift, in a neoclassical economy, will:

lower investment and raise the interest rate.

In the classical model with fixed income, a reduction in the government budget deficit will lead to a:

lower real interest rate.

According to the neoclassical theory of distribution, total output is divided between payments to capital and payments to labor depending on their:

marginal productivities.

The government raises lump-sum taxes on income by $100 billion, and the neoclassical economy adjusts so that output does not change. If the marginal propensity to consume is 0.6, national saving:

rises by $60 billion.

Given that M / P = kY, when the demand for money parameter, k, is large, the velocity of money is ______, and money is changing hands ______.

small; infrequently

If the nominal interest rate increases, then:

the demand for money decreases.

If the ratio of reserves to deposits (rr) increases, while the ratio of currency to deposits (cr) is constant and the monetary base (B) is constant, then:

the money supply decreases.

In the classical model, according to the quantity theory of money and the Fisher equation, an increase in money growth increases:

the nominal interest rate.

In the long run, according to the quantity theory of money and classical macroeconomic theory, if velocity is constant, then ______ determines real GDP and ______ determines nominal GDP.

the productive capability of the economy; the money supply

In the classical model, what adjusts to eliminate any unemployment of labor in the economy?

the real wage

In computing GDP

the value of intermediate goods is included in the market price of the final goods.

To increase the money supply, the Federal Reserve:

buys government bonds.

The inflation tax is paid:

by all holders of money.

Based on the table, what is the reserve-deposit ratio at the bank? Reserves = $10,000 Deposits = $100,000

10 percent

Select the cost of inflation that best describes each scenario. Gita lives in an economy with an inflation rate of 10%. Over the past year, she earned a return of $50,000 on her million-dollar portfolio of stocks and bonds. Because her tax rate is 20%, she paid $10,000 to the government.

Altered tax liability

Select the cost of inflation that best describes each scenario. Grandma buys an annuity for $100,000 from an insurance company, which promises to pay $10,000 a year for the rest of her life. After buying it, she is surprised that high inflation triples the price level over the next few years.

Cost of unexpected inflation

Select the cost of inflation that best describes each scenario. Your father tells you that when he was your age, he worked for only $4 an hour. He suggests that you are lucky to have a job that pays $9 an hour.

Inconvenience of a changing price level

During World War II, both Germany and England had plans for a paper weapon. They each printed the other's currency, with the intention of dropping large quantities by airplane, thereby increasing each other's money supply. Select all of the following reasons that might have made this an effective weapon.

Menu and shoeleather costs would rise. Hyperinflation could undermine the public's confidence in the economy. Relative prices would become more variable.

Select the cost of inflation that best describes each scenario. Because inflation has risen, a clothing company decides to issue a new catalog monthly instead of quarterly.

Menu costs

Function(s) of money for a credit card

Reserve holding Medium of exchange

Select the cost of inflation that best describes each scenario. Maria lives in an economy with hyperinflation. Each day after being paid, she runs to the store as quickly as possible so she can spend her money before it loses value.

Shoeleather costs

Function(s) of money for a Rembrandt painting

Store of value

What are the three functions of money?

Store of value Medium of exchange Unit of Account

Function(s) of money for a Starbucks gift card

Store of value Medium of exchange Unit of account

A farmer grows a bushel of wheat and sells it to a miller for $1. The miller turns the wheat into flour and then sells the flour to a baker for $3. The baker uses the flour to make bread and sells the bread to an engineer for $6. When the engineer eats the bread, what is the value added by each person? What is the bread's contribution to GDP?

The farmer's added value is $1 The miller's added value is $2 The baker's added value is $3 The bread's contribution to GDP is $6

Excess reserves are reserves that banks keep:

above the legally required amount.

If nominal wages cannot be cut, then the only way to reduce real wages is by:

adjustments via inflation.

In a system with fractional-reserve banking:

all banks must hold reserves equal to a fraction of their deposits.

If the demand for real money balances is proportional to real income, velocity will:

be constant.

If the productivity of farmers has risen substantially over time because of technological progress, and workers can move freely between being farmers and barbers, the neoclassical theory of distribution predicts that the real wages of:

both barbers and farmers should have risen over time.

Unlike the real world, the classical model with fixed output assumes that:

capital and labor are fully utilized.

In the case of an unanticipated increase in inflation:

creditors with an unindexed contract are hurt because they get less than they expected in real terms.

The preferences of households determine the:

currency-deposit ratio.

Real GDP is a better measure of economic well-being than nominal GDP because real GDP:

measures changes in the quantity of goods and services produced by holding prices constant.

Open-market operations change the ______; changes in interest rate paid on reserves change the ______; and changes in the discount rate change the ______.

monetary base; money multiplier; monetary base

The characteristic of the classical model that the money supply does not affect real variables is called:

monetary neutrality.

Hyperinflations ultimately are the result of excessive growth rates of the money supply; the underlying motive for the excessive money growth rates is frequently a government's:

need to generate revenue to pay for spending.

A fixed-weight price index like the CPI ______ the change in the cost of living because it ______ take into account that people can substitute less expensive goods for ones that have become more expensive.

overestimates; does not

The economy begins in equilibrium at point E, representing the real interest rate r1 at which saving S1 equals desired investment I1. What will be the new equilibrium combination of real interest rate, saving, and investment if the government cuts taxes, holding other factors constant?

point A

The economy begins in equilibrium at point E, representing the real interest rate r1 at which saving S1 equals desired investment I1. What will be the new equilibrium combination of real interest rate, saving, and investment if there is a tax law change that makes investment projects less profitable and decreases the demand for investment goods (but does not change the amount of taxes collected in the economy)?

point A

Consumption depends ______ on disposable income, and investment depends ______ on the real interest rate.

positively; negatively

The currency-deposit ratio is determined by:

preferences of households about the form of money they wish to hold.

Over the past century, the productivity of barbers (MPLb) has remained constant. According to the neoclassical theory, barbers' real wage (Wb/Pb) should have

remained constant.

Your answers in parts a through d imply that the relative price of haircuts, Pb, has ______ relative to the price of food, Pf.

risen

Two equivalent ways to view GDP are as the:

total income of everyone in the economy or the total expenditure on the economy's output of goods and services.

In arts a and b, real wages are measured as

units of output per hour worked.